Fed Continues to Punish the Dollar, Blind to Inflation

Fed policy sinking greenback to the bottom of the currency ladder

At the last minute Friday night, the federal government dodged a bullet and avoided closing down. The market was flat last week, so it’s safe to say that the impending shutdown was not as scary to Wall Street as it was to those expecting their regular government services. Of course, nothing was solved for the long-term, and the U.S. dollar will continue to slide — based on Washington’s inability to control spending — while the U.S. economy has been humming along just fine, with or without federal government help.

Dollar Sinks to the Bottom of the Currency Ladder

The euro hit a 15-month high to the U.S. dollar last week after the European Central Bank (ECB) raised its key rate by 0.25% to 1.25%. The People’s Bank of China also raised its key rate last week, up 0.25% to 3.25%. Meanwhile the Fed continues to maintain its 0% interest rate policy and quantitative easing.

The euro-zone is a mixed bag of good and bad news. On the positive side, Germany’s factory orders rose by 2.4% in February. That helped to strengthen the euro. On the other extreme, Portugal had to pay six-month interest rates of 5.11%, up from 2.98% just a month ago, so a bailout of Portugal (similar to the previous rescue plans in Greece and Ireland) may be necessary, pushing the euro-zone deeper into debt.

So far this year, 18 developing economies have raised interest rates, but last week Australia, Britain and Japan decided to leave their interest rates alone. On Tuesday, Australia announced a surprising February trade deficit – due largely to Queensland’s devastating floods — so it is no surprise that Australia left its key rate unchanged at 4.75%. But the Bank of England surprised observers by leaving its key interest rate unchanged at 0.5%, despite the fact that inflation is now running at 4.4%, more than double it 2% target. Also, Japan’s central bank left its key rate at 0% in the wake of its devastating earthquake and tsunami.

The global power shift now favors currencies with higher interest rates and rich deposits of high-priced natural resources, such as Australia and Brazil. Last week, the dollar lost 2.7% to the Brazilian real and 1.4% to the Australian dollar. Since last May, the U.S. dollar has fallen 23% to the Australian dollar and 16% to the Brazilian real, but last Wednesday, Brazil’s Finance Minister Guido Mantega proposed a series of currency controls, including an extension of a 6% tax to keep U.S. dollars out of Brazil, to slow the real’s appreciation. Mantega seemed outraged that rich countries like the United States are fighting a currency “war” to keep the dollar weak, causing a rush of capital into currencies throughout the developing world.

From our perspective, a weak U.S. dollar is clearly stimulating U.S. economic growth and boosting corporate profits, especially in multi-national companies. That is the good news. The bad news is that most of the world’s commodities are priced in U.S. dollars, so commodity prices continue to rise as the U.S. dollar falls. However, the stock market is shrugging off this threat, since a weak U.S. dollar also boosts earnings of many companies with overseas operations, making stocks a great inflation hedge!

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